In a ruling released this afternoon Justice Matthew Palmer said a complex 2002 transaction - involving Cayman Island companies while Watson himself was relocating from New Zealand to the United Kingdom for tax purposes - was an avoidance arrangement.
The case represents one of the largest tax judgments in New Zealand history. Watson's Cullen Group was ruled liable for $51.5m in back taxes, plus interest and penalties.
During a three-week trial last year the court heard Inland Revenue considered interest costs alone amounted to $60.5m. Penalties were yet to be quantified, Palmer said.
The consequences for Watson personally from today's ruling are unclear, but they represent another setback for the increasingly beleaguered businessmen.
Since becoming a society page fixture in the 2000s with lavish living and relationships with lingerie models, Watson has since faced fallout from the collapse of Hanover Finance and a succession of losses in high-stakes court proceedings against fellow mogul Sir Owen Glenn.
Today's ruling is a significant milestone in a protracted legal struggle - the trial last year heard Inland Revenue's interest in Watson stretched back more than a decade and the proceedings had their origin in a 2004 audit of the rich-lister - but given the sums involved is unlikely to mark a final conclusion given both sides have the means to appeal.
The core of the dispute between Watson's Cullen Group and Inland Revenue were corporate manoeuvres beginning in 2002 that saw Watson transfer the ownership of the bulk of his business empire - said at trial to be worth $291m at the time - to the newly-incorporated Cullen Group.
The transaction was paid with related-party vendor finance, with loans made by what Palmer described as "conduit companies" Modena Holdings and Mayfair Equities registered in the Cayman Islands.
The move - with Modena and Mayfair being not technically "associated persons" - meant only a 2 per cent levy under Approved Issuer Levy (AIL) regime was paid on the transaction rather than a 15 per cent Non-Resident Withholding Tax.
Inland Revenue contended the AIL regime was intended to facilitate foreign direct investment into New Zealand, and its use in a transaction like this was outside the contemplation of parliament.
The case boiled down to a contention from Cullen Group that it had scrupulously followed the letter of tax laws, while Inland Revenue relied on a "general anti-avoidance provision" allowing it to assess the use of specific tax provisions with the intent for which they were brought into law to determine if arrangements were artificially contrived to avoid tax.
Justice Palmer said this provision was to "prevent avoidance of the law by clever tax lawyers and accountants".
"Ï consider the use of the AIL regime by this sort of arrangement, which would not erode the tax base, was not within Parliament's contemplation of purpose ... The success of Mr Watson and his advisers in bringing the arrangement within the terms of the specific AIL provisions does not mean Parliament contemplated that would or should occur," Justice Palmer said.
The judge found Watson was a central figure in all entities involved in the transaction - including a handful of other trusts - and taken as a whole they were "highly-related parties."
"In reality, Mr Watson was on both sides of the loan transaction," Justice Palmer said.
Cullen Group had challenged the assessment of avoidance, and also argued Inland Revenue had calculated tax owed unlawfully and had taken too long to do so.
Justice Palmer ruled today that Cullen Group's challenge had failed on all counts.
Lawyers for Cullen Group argued the transaction wasn't intended to avoid tax, but rather required for Watson's relocation to the United Kingdom, where he needed to sever local ties in order to abandon New Zealand tax residency and qualify for non-domiciled status in London.
Justice Palmer also rejected this argument.
"Selling [Cullen Investments] shares for this purpose did not require the complex structure set up in the arrangement, particularly the use of Modena and Mayfair," he said.
Inland Revenue legal services leader Karen Whitiskie says the decision today is the "culmination of a lot of hard work by many people".
"The outcome of the High Court process is the result of hard work and dedication by the Inland Revenue team, Crown Law and Counsel. This was a long-running issue and shows the dedication of our people in unravelling what went on," she said.
